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Explanation:
The Fama-French three-factor model differs from the CAPM in that it adds two additional factors beyond the market risk premium:
Key Differences:
Why Option C is Correct:
Why Options A and B are Incorrect:
For small-cap value stocks specifically, the Fama-French model would likely show positive loadings on both SMB (small size) and HML (value) factors, explaining their historical outperformance that CAPM cannot capture.
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An investment analyst is evaluating the performance of a portfolio of small-cap value stocks. They are considering using the Capital Asset Pricing Model (CAPM) and the Fama-French three-factor model to estimate the expected returns of these stocks. Recognizing that small-cap stocks and value stocks have historically outperformed the market, the analyst wants to understand how the Fama-French model might provide a different perspective compared to the CAPM. Which of the following statements correctly describes how the Fama-French three-factor model differs from the CAPM in estimating asset returns?
A
The Fama-French model incorporates macroeconomic variables, such as inflation and GDP growth, to capture systematic risks not accounted for in the CAPM, which relies solely on the market risk premium.
B
The Fama-French model estimates expected returns by incorporating the effects of macroeconomic variables, such as GDP growth and inflation, alongside market risk.
C
The Fama-French model expands on the CAPM by adding factors related to firm size